Passing on family wealth – the Family Law impact of the new inheritance tax changes

The Budget of 30 October 2024, arguably one of the most crucial of the last two decades, has been met with criticism by some who feel they have lost out with the new changes – our colleagues in the Private Client department discuss this in more detail in relation to Inheritance tax (“IHT”) in their article Budget 2024 - IHT winners and losers. We look at the changes from a Family Law perspective.

Freeze on the thresholds

The freeze on the £325,000 threshold has been extended until 2030, meaning inheritance tax will still only be paid on estates valued at over £325,000 (or another way to look at it is that up to £325,000 worth of assets can be inherited tax free). The residence nil rate band (which relates to the passing of a main residence to direct descendants) remains at £175,000.

Whilst only a very small number of estates across the country fall outside of these thresholds (meaning IHT is to be paid), property prices vary significantly throughout the country and so it may well be that inheritance tax planning methods will vary depending on location. For example, the average property value in London (reported as £691,565 – well exceeding the IHT threshold) is far greater than the average property value in the North East of England (£189,443).

Passing on family wealth

Potentially exempt transfers (PETs) will not be subject to IHT if the donor survives for 7 years from the date of the gift. There was some speculation pre-Budget that the 7 year period could be extended, however, this has not been done (yet) and the 7 year time period still stands. It may therefore be that some wealth is passed on to younger generations via the mechanism of a PET in order to save or reduce potentially hefty IHT bills.

What are the consequences of this? Some parents may pass on wealth to their adult children sooner, for example gifting them a large sum of money or transferring property, in the hope of avoiding IHT on that gift or transfer. They may also  then ask that the child seeks to protect or ‘ringfence’ this as best they can – for example, by entering into a nuptial agreement (either a pre-nuptial agreement if they are not yet married or a post-nuptial agreement if they are). Nuptial agreements are increasingly used as wealth management tools and, whilst they are not legally binding as contracts, they should be given effect to if there is financial disclosure (when the agreement is entered into) and if the agreement is entered into freely with a full appreciation of the implications - unless it would not be fair to hold the parties to their agreement.

Family money or inherited wealth is often a particularly contentious and sensitive subject and how the court considers inherited wealth on a divorce will largely depend on the circumstances of the case, including the parties’ respective needs and whether it has been ‘intermingled’ with other assets. Once inherited wealth has been mingled with other assets, for example the family home, it is then much more difficult to argue that this should be considered separately to other assets or ringfenced for a particular spouse, and the length of time that has passed since the inheritance was received will also be relevant. This is one reason why nuptial agreements can be a useful wealth management tool.

Another potential consequence to be considered is that if  parents who have gifted wealth to their adult children later separate and divorce, the available assets and resources for them may well be significantly depleted. Any valid gifts made to adult children would no longer be considered as part of the gifting parents’ assets.

An impetus for family wealth planning?

The recent changes to  IHT have been hard hitting for some –for example, farmers who say the changes will ‘cripple’ them – see more in our colleagues’ article here A chink of light in an otherwise gloomy budget for farmers and rural business owners?) However, even for those who are unaffected by the immediate changes, the Budget may well still be an impetus for some families to consider planning strategies for their  wealth –particularly as the treatment of inherited wealth in a divorce  remains a difficult issue.